Moderating inflation is particularly good news for Associated British Foods PLC's Primark chain, say analysts at RBC Capital Markets, leading to them upgrading their recommendation.
“We think an improvement in Primark profitability should drive double-digit earnings growth for ABF, which is not being captured by the current valuation,” the analysts said, moving to an 'outperform' rating from the previous 'sector perform'.
Due to the size of its fast fashion business, AB Foods is one of the companies most sensitive to moderating inflation trends, they explained.
Last month's results showed how, despite strong sales growth, inflationary pressures ate into margins.
Primark, the FTSE 100-listed group's main business at 44% of sales and 51% of profit, has a" fairly low gross margin meaning it should see a strong improvement in profitability in FY24,” the analysts said.
What's more, currency and raw materials rates look "neutral to slightly positive" for Primark's gross margin, they added, while being a big volume player in freight means it should see a material benefit from falling freight costs.
There is also "attractive" potential seen for Primark to expand shop space in Europe and the US, with a growth rate of 5% over the next 10 years supporting "at least mid single digit sales growth", with the low market share in several European markets and US.
Meanwhile, the Grocery arm, which makes Twinings, Ovaltine, Patak’s, Kingsmill, Jordans and many others, is estimated will generate 7% profit growth this year, according to RBC's model, or 13% if excluding the sugar business.
“In particular Ingredients has been performing very well and is now generating close to 15% of group profit.”
RBC has lifted its price target from 2,150p to 2,250p offering around 17% upside from today's share price of 1,917p.